Does Manager Ability Influence Prospectus Earnings Quality and IPO Underpricing?

Abstract

Prior literature suggests that manager ability influences several factors, including financial reporting quality, key to the bargaining power of an issuing firm during their initial public offering (IPO). However, we also know that high ability managers are better able to engage in and conceal opportunistic behavior which may dampen any positive effects their abilities have in the IPO process. Given the conflicting affect that managerial ability may have on financial reporting and firm performance in the IPO setting, we examine the impact of manager ability on prospectus earnings quality and IPO underpricing. We find that IPO firms with high ability managers tend to have better earnings quality and are less underpriced than firms with low ability managers. We also find preliminary evidence that equity ownership strengthens the relationship between manager ability and IPO underpricing. Our findings are consistent with the streams of literature suggesting that better managers produce higher quality earnings and raise more capital during the IPO to invest in future growth opportunities if they are closely monitored. These findings should be useful to issuing firms considering hiring high caliber managers, investors in evaluating IPO firms, and researchers in examining the influence of human capital on IPO underpricing.